As the war in Ukraine began, we wrote about how commodities would be affected and, in fact, how Putin would use food as a weapon. Beside the problem of the war, widespread droughts are affecting many grain harvests. In fact, corn, wheat, barley and other grains are not the only crops being affected by lack of rain. Cotton crops and worldwide cotton supply are currently threatened by drought as well as torrential rains and crop diseases. Fortunately, neither Russia nor Ukraine are major cotton producers. This unfortunate situation holds opportunity for the options trader in cotton futures options.
Extreme Weather and Cotton Supplies
The four largest cotton growers are India, China, the USA, and Brazil. India is not an efficient grower with weak yields per acre but they make up for it by planting far more area than any other nation. China, the USA, and Brazil are all experiencing reduced crop yields due to drought while India is expecting a lower yield due to torrential rains and pests. The four major producers typically make up three-fourths of the world’s cotton output.
Fluctuating Cotton Prices
Cotton futures peaked at the end of May 2022 from a low at the end of March 2020. The price had gone up by 250%. By end of July 2022 the price had fallen again by nearly 50%. This is the perennial story with agricultural commodities and weather conditions hold the key to the supply side of the supply and demand equation. While Brazil is the fourth largest producer it is the second largest exporter and their yields are already down by thirty percent due to drought. The USA is expected to see a similar fall in output in the coming year. The USA and Brazil account for half of world exports of cotton.
Cotton Price Fallout Beyond the Commodity Market
Cotton is used for clothing but also paper, diapers, and cardboard. Manufacturers of all products using cotton are caught in a price squeeze as the weather affects cotton prices and, in turn, drives up inflation. The saving grace in the supply and demand equation for cotton is the likelihood of a global recession centered in Europe and Asia which will reduce demand for purchases of clothing. Nevertheless, shrinking crops are likely to drive cotton futures higher in the months to come.
Trading Cotton Futures and Options on Futures
Cotton futures are traded on the NYMEX, the New York Mercantile Exchange. Prices are quoted in dollars and cents per pound for delivery of set quantities of cotton. Cotton producers commonly use a short hedge to lock in the price at which they will sell their harvest. Cotton buyers such as clothing manufacturers use a long hedge to fix their buying price. Traders can speculate in this market but need to exit their contracts before expiration to avoid having to take delivery or make delivery of actual bales of cotton. Like cotton futures, options on these futures trade on the NYMEX. The contracts are American style options.
Always Hedge Your Options Trades
At Top Gun Options we constantly remind our traders to hedge their trades. The commodities markets can be extremely volatile. This makes trading cotton and other commodities potentially extremely profitable and potentially extremely dangerous. We have said frequently that today’s markets hold promise and risk and that this is not a good time to be trading options alone. That advice is doubly important for anyone who wants to trade cotton futures options in the current market. You best route to success in options trading is to join one of the trading squadrons at Top Gun Options where we potentially print money no matter which direction the markets are headed.